Interest in China's private equity space has been growing over the past decade and seems to show no signs of abating -- total transaction volume has increased from US$19.7 billion in 2013 to US$66.7 billion in 2018 at a CAGR of 28%1 . Now, there are ample private-equity opportunities across multiple sectors and different strategies along the various stages of the business life cycle.
1 “Asia Private Equity Review", 2017 and 2018
Private equity in China can be categorized by the type of investment opportunities focused on. Here we show the investing options available for this asset class, together with the value of new funds raised for the different private equity strategies for China in 2018.
China is the largest market for private equity in Asia Pacific, accounting for over half of the aggregate investments (about US$165 billion in 2018). It is also one of the fastest growing markets in the region -- total private-equity investment value in China rose to US$94 billion in 2018, up 64% over the previous five-year average. The market's growth has been driven by China’s evolving economy, whereby more and more businesses are entering the advanced or mature stages of their growth life cycle, thereby giving rise to buyout and special situation opportunities.
Improved overall return profile
Historically, private equity returns have tended to outperform public equity globally, and China is no exception. Given the highly illiquid nature of private equity funds and the long duration before distribution of investment returns, investors have seen positive risk-adjusted performance. In this respect, China has outperformed the rest of the world, on both absolute as well as risk-adjusted basis.
Relative mitigant to public equity
Private equity is imperfectly correlated to public equities, which in turn has driven its historical return performance. Although private equity returns would suffer in times of prolonged economic distress, they tend to exhibit less volatility to short-term shocks.
Depth of knowledge
Because private equity managers invest in, work with, or own and run mostly privately-owned companies, they gain great specialization of specific industry verticals. These views help the limited partners form a more holistic picture and better understanding of the overall investment opportunities.
Given its growing private sector, China's private equity investment landscape is full of opportunities for private equity firms in the upcoming years. Buyout deals are on the rise amid more instances of debt restructuring and ownership transfers amid generational and succession changes.
There are three major ways investors currently access private equity in China:
USD and RMB private equity
While the private equity pool in China is split into USD and RMB, an overwhelming number of foreign investors typically invest into the former. USD pools are well-established, based on highly-standardized set of terms between the fund manager and investors, and governed by a common law jurisdiction. Many of these managers tend to be regional or global in nature, and investors can delegate the task of managing currency risks to them. RMB pools are governed by Chinese laws, have a shorter history and are based on more bespoke terms that are often negotiated on a case-by-case basis.
Third-party channels (fund of funds or professional consultant/advisors)
These provide more exposure to different private equity (PE) vehicles and allow a greater time window to observe and learn about the Chinese PE market. However, investors end up paying two layers of fees.
Most investors with existing PE programs and allocations tend to invest by directly engaging the managers, where they assess the managers based on several attributes. Beyond investing through a longer-term private equity vehicle which could be a substantial commitment, investors can also "cherry pick" on a deal-by-deal basis, selecting the opportunity they deem to be the most attractive. This gives them the benefit of flexible capital deployment and a direct window into underlying market opportunities.
While considering the above-described choices when accessing China’s private equity market, investors would also need to take into serious consideration some China-specific factors, such as macroeconomic risks, policy and regulatory risks, enforcement of legal rights and a rapidly-changing market environment, etc.
The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.